These assets are mainly digital representations that cannot be copied or duplicated but are transferable.
The design of these assets along with the underlying technology, called the blockchain technology or the Distributed Ledger Technology, helps them to operate in a decentralized manner.
The benefits offered by these assets such as ease of use, faster transfer and more has helped them in proliferating into a multiplicity of business uses.
These currencies share a few similar characteristics with traditional currencies and its market is growing at a fast rate.
Apart from that, there are also different other categories of crypto assets as classified by the Accounting Standards Advisory Forum or ASAF, a forum of the IFRS or the International Financial Reporting Standards Foundation.
It is done on the basis of the holder’s perspective and few specific characteristics such as:
- The use of cryptography to record a transaction on the distributed ledger for security
- It is not issued by any jurisdictional authority or any other party and
- It does not translate into a contract between any party and the holder of the assets.
Apart from that, there are a few judgmental areas to consider for determining the accounting treatment applicable.
With these come the need for proper accounting of these assets by businesses, and this, by itself, is a complex subject.
If you want to know more about crypto accounting, you will first need to know about the categorization of these assets into different subsets.
And, for that, you are in the right place. This article will tell you how the process of categorization differs according to purpose and the holders.
You will also come to know about the pertinent characteristics and the factors that you need to consider for a proper accounting of your crypto assets.
How Crypto Assets are Categorized into Subsets for Accounting Purposes?
It includes crypto coins, utility tokens, tokenized securities, platform tokens and more.
These are actually tokenized assets issued in a blockchain but the value of them is not derived from the chain.
Moreover, the purpose of these assets does not start and end with making payments only.
Crypto assets got their name because these can be converted into cash when it is necessary and can store value.
Some of the crypto assets may have a finite supply while others may have indefinite supply but this does not mean that the coins with infinite supply will have less value as compared to those that come with a finite supply.
The supply of crypto assets can be divided into three specific types.
- Circulating supply – This represents the number of coins circulating and available in the market as of now
- Total supply – This is the total number of coins existing in the market, circulating or not and
- Maximum supply – This is the maximum number of coins that can ever exist for a given crypto asset.
Each type of crypto asset comes with different algorithms depending on their use cases such as:
- There may be some that may be launched with the maximum supply but it gets reduced with increased usage, like Ripple.
- There may also be some launched with a lower circulating supply but gets added to reach to the maximum supply when the coins are mined with every transaction, like Bitcoin,
- And, there may be some that are launched with a total finite supply that can be earned with every transaction that is processed, like Ether.
However, irrespective of the algorithm involved with it, it is actually the blockchain that differentiates every crypto asset.
Types of crypto assets:
As of now there are thousands of companies out there that offer an equal number of crypto assets having different utility.
- Monero focuses on privacy
- Ethereum operates on smart contracts
- Kodak allows registering photos by the photographers through blockchain
- Spotify allows music licencing
- Siacoin creates a network of data centers for people to offer unused hard drive and earn money
- Steem allows monetizing contents of publishers by using Smart Media Tokens and building a community and lots more.
All these crypto assets cannot be considered as crypto coins because the aim of these is not to replace money.
Therefore, it is imperative that these crypto assets are categorized for accounting purposes.
This categorization is typically done on the basis of a few specific factors such as:
- Their characteristics
- Their technical layer
- Their use cases
- Their value dependency
- Their utility and
- Their legal status.
Based on the factors mentioned above, the crypto assets can be divided into these following main types.
Needing no special introduction, these well-known, decentralized, native blockchain crypto assets come with the basic characteristics of fiat currency.
These coins are specifically used as digital currency and to make faster-than-fiat transactions. Their value is based on:
- The total supply and the circulating supply of the coins
- The type of blockchain
- The demand for them in the market and
- The rate at which new coins can be generated.
This means that the utility of every crypto coin is not the same.
These coins are typically backed by P2P network mining through millions of computers spread all over the world.
Bitcoin, Bitcoin Cash, Dash, are just a few examples of them.
These crypto assets are the tokens that act as a platform for designing other decentralized projects.
It is based on the blockchain technology and a database is built and distributed among all the participants or the computers linked to that particular blockchain.
This database cannot be damaged or shut down and therefore these are devoid of the limitations associated with the traditional servers. All the computers verify every transaction to remove any discrepancy in them.
One of the most commonly known crypto assets of this type is Ethereum which works on smart contracts to validate a transaction or even build other crypto assets on it.
The value of these specific types of crypto assets increases with their usage.
This is because these tokens are used to pay for the gas fees to access and use the platform.
There are thousands of these types of platform tokens available out there and some of the major ones are Ethereum, Ethereum Classic, EOS, Neo and more.
The utility tokens are also called the protocol tokens and represent decentralized services or units of it that can be bought, sold, or earned.
These tokens are pretty similar to real-life service tokens and can be exchanged for particular services such as video game coins, distributed storage, and more.
This means that these crypto assets are designed to have a specific use case and serve as an API key to access any particular service.
The utility tokens are usually launched before the launch of the actual project or even when it is in its beta or MVP stage.
This means that the value of the utility tokens depends on the demand for it in the market which varies depending on the ability of the team behind the project, their PR and progress.
The most significant difference between the utility tokens and the crypto coins is that these tokens do not depend on the blockchain directly.
Instead, most of these tokens are dependent on the ERC 20 platforms for running and are derived directly from the use case.
A few examples of utility crypto assets are Golem, Siacoin, Sonm, Augur, OmiseGo and others.
Transactional tokens or payments tokens:
These are specific types of crypto assets that solve the issues of making cross-border payments that the traditional banks and financial institutions are unable to solve.
Based on more advanced technology in place of the age-old SWIFT that involves AML and KYC requirements and 6 different parties, these crypto assets enable making faster transactions.
One of the best examples of transactional or payment crypto assets is Ripple that allows making real-time settlement on a global scale through a network that connects several banks and financial institutions.
There are several transactional and payment tokens launched over time that focus on corporations and individuals.
- Stellar utilizes lumens to facilitate transactions
- IOTA handles micropayments made by the use of Internet of Things or IoT and
- Metalpay uses blockchain to transfer funds across borders by using simply a phone number.
The payment or transactional crypto assets can be further subdivided into two specific groups such as:
- Blockchain-based transactional tokens – These are the 1st and 2nd generation tokens that rely fully on blockchain technology to execute, conduct and secure transactions without violating government policies and are considered to be stable investments unlike crypto coins such as Stellar.
- Internet of Things-based transactional tokens – These tokens facilitate making machine-to-machine transactions and micro transactions without using blockchain for it. Instead, these tokens use a tangle or a Directed Acyclic Graph to handle the transactions. The advantages offered by these tokens include zero transaction fees. Some of popular examples of IoT-based platform or transactional tokens are IOTA, VeChain, and more.
One significant benefit of using the platform or transactional tokens is that there is no need for any intermediaries or other beneficiaries to make cross-border payments in seconds.
It also offers end-to-end visibility of the entire process.
The reserve crypto assets are crypto coins but mainly consists of only two types of it namely, Bitcoin and Ether.
These two coins are different in several aspects but the market quality of the two is similar and is not shared by any other type of crypto assets.
Both these coins can be mined and come with specific monetary policies.
Bitcoin is deflationary in nature with its limited supply of 21 million coins and Ethereum is a platform that comes with a different set of demand and supply mechanics than Bitcoin.
Since these two coins hold special dynamics in the market, these are considered as reserve tokens.
You should not mix up security tokens with utility tokens because these two are different types of crypto assets in terms of their features, functionalities, objectives and regulatory risk profile.
These specific crypto assets derive their value from their link with an external and real-world asset and their valuation model relates to the underlying asset of these tokens directly.
Though these commodities fall in the platform asset class, its primary objective is to offer a direct consumable source.
It is a bit different from the traditional platform tokens because these tokens are industry or vertical specific and can be exchanged depending on the particular subset of resources.
These resources include computing power, disk space, and other different consumable services.
These commodities are also different from the utility tokens in terms of the valuation model which is subjective simply to the demand and supply of the given resource.
This model is typically influenced by the effects of the network but is different from the currencies that are valued based on the platforms and velocity of money.
However, it is these mechanics that affect the price of the tokens because it is based on the supply and demand.
Therefore, there are scarcity and price surge risks that may occur regularly with commodities other than utility tokens or app coins.
These tokens also operate on their own blockchain and are therefore different in the way of operation of the utility tokens.
However, these tokens come with fewer regulatory risks since the resource is exchanged. Some good examples of commodities are STORJ, Golem, and FileCoin.
dApps or App coins:
These particular crypto assets run on a particular network in order to provide a certain vertical application service.
The App coins, also called Decentralized applications or dApps are different from crypto commodities in terms of their supply.
This supply is not a resource that is consumed or is constrained like in commodities.
These App coins are also different from platforms because these are application-specific.
These assets do not act as a platform or a protocol that allows others to build upon them.
The primary objective and utility of these coins is to focus on their ecosystem that is particularly narrow and they come with a many-to-one relationship network model and is therefore not like the utility tokens that have a many-to-many relationship.
Since the App coins have narrow applications these can be levered to a particular use case.
As a result, these ‘pure play’ applications have a valuation model that is different from commodities, platforms or currencies. Some examples of App coins are Binance Coin, Steem, and SALT.
Finally, the stablecoins are specific types of crypto assets that offer a stable store of value being pegged to a valuable asset.
This new and rapidly increasing asset class is supposed to change the future of finance since it comes with its own stated objective as well as having a more functional nature.
Some of the most popular stablecoins are Tether, Basecoin, Maker, and Digix, just to name a few.
In terms of accounting purposes of the crypto assets, it is important to realize the relevant characteristics so that you can determine which particular accounting standard is applicable and what are the issues related to it.
Unfortunately, as of now, there is no single framework existing for the classification which is generally accepted for these varied crypto assets for their accounting purposes.
This is because there is no proper definition of crypto assets that is applicable in general.
However, you will get a lot of help in this aspect now that you know the different subsets of the crypto assets.
Classification and characterization of crypto assets into similar groups is usually done on the basis of the features and customized nature of the transactions that are in practice.
However, based on different observations, these are the pertinent characteristics of cryptographic assets for accounting purposes:
- The main purpose of the asset and
- The way in which the asset derives its intrinsic value.
Though there are several other characteristics that you may consider, these two are considered to be the fundamentals for determining the common accounting treatment.
Crypto Assets Held for Own Account
The accounting procedure will typically differ on the way a crypto asset is held by the user.
For example, when crypto assets are held for their own account, here are the specific things that will be considered.
Here are a few standards that may come to your mind to apply for accounting the crypto assets, especially cryptocurrencies you hold in your own account.
Cash or a currency:
Since the IFRS does not explicitly define ‘cash’ or a ‘currency,’ there may be an argument for accounting purposes since these terms are interchangeable.
IAS 32, Financial Instruments Presentation correlates cash and currency and IAS 21, The Effects of Changes in Foreign Exchange Rates correlates cash, currency and monetary items.
Therefore, judgment is required to determine whether crypto coins in particular can be considered as cash or a currency.
Typically, cryptocurrencies will not be considered as cash or a currency if these are not legal tender and are not issued or backed by the state or government and cannot set the prices of products and services directly.
Any financial asset but not cash:
Usually, the law does not give any contractual right to the holder of crypto to receive cash or any other type of financial assets and it also does not consider any contractual relationship to exist.
Furthermore, it also does not provide the holder any residual interest on the crypto asset after taking away all of the liabilities.
Therefore, as of now crypto assets, especially cryptocurrencies, do not meet the requirements to be considered as a financial asset for accounting purposes.
Property, plant or equipment:
Considering the scope of the IAS 16, Property, Plant and Equipment, crypto coins do not fall under it as well because these are not tangible items, or, in simple words, do not have a physical form.
According to IAS 2, inventory does not need to have any physical form but it should be held for sale in the normal course of business.
If that is done, then crypto assets can be considered as inventory for accounting purposes.
However, if profit is generated due to traders’ margin or fluctuations in the price you should refer to the IAS 2 guidelines for commodity broker-traders to see if it is applicable.
If the assets are held simply for investment purposes or with an expectation for capital appreciation over a long period of time, it may not be considered as an inventory for accounting purposes.
If none of the above is applicable for the crypto asset, it is likely to fall under the intangible asset category according to the definition in IAS 38, Intangible Assets.
This is because it can be a resource controlled by the entity and to enjoy the economic benefits due to some past events or anticipated future benefits to flow.
If it can also be sold, transferred or exchanged and therefore can be identifiable individually and if it is not a cash or a non-monetary and does not have a physical form, it can be considered as an intangible asset according to IAS 38.
And, if you hold cryptographic assets other than cryptocurrencies in your own account, the applicable standard for accounting purposes will be different and as under.
Remember, these can be anything from security tokens, utility tokens, asset-backed tokens or others held in your own account.
Cash or a currency:
Crypto tokens are usually also not issued as a medium of exchange for general purpose but simply to provide the holders with supplementary rights such as rights to the physical assets underlying or to goods or services.
Once again, judgment is required to figure out whether these tokens will be cash or a currency.
However, crypto tokens normally lack the properties of cash or currency and therefore cannot be considered likewise according to the IFRS.
Any financial asset but not cash:
There are a few specific types of crypto tokens that offer the holder with the right to a financial asset other than cash.
This is normally dependent on the future performance of the platform, the value of the asset underlying it or the residual interest in net assets.
However, you should verify further whether such obligations or rights are enforceable legally because financial assets are considered to be those that arise from a contractual relationship that is legally enforceable.
Also, crypto tokens can only be considered to be a financial asset if it meets the definition of it according to IFRS 9, Financial Instruments.
This means that if it does not provide you with the right to cash or other financial assets it will not meet the definition.
Property, plant or equipment:
Cryptographic assets other than cryptocurrencies typically do not fall under this category according to the definition in IAS 16, Property, Plant and Equipment since these are not tangible items.
Therefore, you cannot use them as property, plant or equipment for accounting purposes.
Crypto assets other than crypto coins may also meet the definition of intangible asset in IAS 38 if the resource is controlled by the holder and if it is identifiable individually or is not a cash or a non-monetary asset and does not have any physical form.
Crypto Assets Held for Third Parties
If you are holding crypto assets on behalf of your customers or third parties the accounting considerations will be different.
Some examples of these types of holders are:
- A trading platform that allows customers to exchange different types of crypto assets or fiat money for a crypto asset and
- A bank or any similar financial institutions offering custodian services to the customers for their crypto assets with an intention for safe keeping.
Such types of arrangements for holding crypto assets may also vary but there will be some clear indication such as there will be a statement or a contract indicating that the crypto assets are held on behalf of the customers.
It should also mention what the customers need to do in order to access and use these crypto assets.
The other variable features of such type of arrangement include and are not limited to the following:
- Explicit or implicit right of the entity to borrow the crypto assets for own use based on the degree of separation of the assets of the customers
- The degree of separation of crypto assets held by an entity on behalf of the customers from the assets owned by it
- The claims in the event of a liquidation of the entity by the customers that may be unclear or vary such as for unsecured creditors having no privileged claim on the crypto assets held on their behalf by the entity
- The security aspect of the crypto assets held by the entity on behalf of the customers depending on whether it is held in a hot wallet connected to the internet, an offline warm wallet that can be connected easily than a cold wallet by using hardware, or a cold wallet that is harder to access being not connected to the internet
- The degree to which the entity or the exchange or the customer can identify by using blockchain technology any particular crypto asset that is misappropriated
- Whether the assets are held on behalf of the customers by the entity in their own account or wallet or that of any third party
- The laws and regulations, if any, pertinent to the crypto assets held on behalf of a third party by the entity and
- The extent of clarity of the rights and obligations of the two parties or the contract that is enforceable or the external legal opinions available.
The last factor related to the laws and regulations around crypto assets may not be very conclusive because these are still being developed.
However, the main question related to accounting crypto assets is whether or not holding these assets on behalf of customers or other third parties should be recorded at all in the balance sheet of the entity according to the IFRS.
Factors to Consider for Accounting
Now, when it comes to accounting treatment for crypto assets, there are a few specific factors to consider.
This will help in determining the standards since there are no specific IFRS guidelines for accounting crypto assets.
Ideally, it is believed that it is much better to follow the common guidance in IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors.
This will be of significant help when you develop the accounting policy for your crypto assets as well as to determine whether or not these should feature in your balance sheet in the first place.
For this you will need to consider the existing IFRS rules for dealing with any issues.
First of all, you should know the definition and distinctive features of assets and liabilities based on the definitions in the Conceptual Framework.
According to the Framework, these two terms are defined as follows:
- Asset – This refers to the current economic resource that is controlled by the holder consequent to the past events. Here economic resource refers to the right that can generate economic benefits.
- Liability – This refers to the current or existing obligation of the holder to transfer the economic benefits when realized due to the past events.
Now, you should consider whether or not the asset or liability should feature in your balance sheet if you hold them for your customers or any third party. For that you will need to consider the following factors:
- Whether or not you have the explicit or implicit right to borrow the assets and use for own purpose and, if you do, it will be considered as an asset and it should feature in the balance sheet and
- The rights of the customers of the crypto assets held by you on their behalf in case of liquidation and if their status is of unsecured creditors having no preferential claim on the assets, it should be considered as your liability and therefore should feature in the balance sheet.
In practice, it is also crucial to determine the degree of segregation of the crypto assets of the customers from that of the entity.
This will also help significantly while determining whether or not a particular crypto asset should feature in your balance sheet.
- The balance sheet should include your own assets and the assets of the customers as well if these are not clearly segregated and
- The balance sheet may exclude those particular crypto assets that are clearly segregated but are held by you as a custodian.
The factors to consider in such situations include and are not limited to:
- Whether or not the whitepaper, if any, clearly mentions the rights and obligations of the entity and the customers
- Whether or not these rights and obligations are contractually enforceable
- Whether or not any external legal opinions as evidence are available
- Whether or not the enforcement of these laws and regulations can be assessed with reference to the specific crypto asset being addressed
- The extent of these laws and regulations as well as the context of other rules and regulations
- Whether or not there is reconciliation between the entity holding the crypto assets and the customers
- Whether or not the individual holdings of the customer is shown in their account statement
- Whether or not there is any reconciliation between the orders executed on behalf of the customers and the market in which it is executed
- Whether or not the transaction can be ascribed to the relevant customer and can be assessed
- The frequency of such reconciliations made and
- The traceability of the committed blockchain address and does it indicate segregation.
Therefore, with the absence of an IFRS guideline that is specific for accounting crypto assets, there is a lot for an entity to do, preferably with the help of a professional accountant knowledgeable about the intricacies of crypto assets.
Remember, in this particular aspect, there is no ‘one size fits all’ approach.
So, that is all about classification and considerations of crypto assets for the accounting purposes. As it is clear from the article it is the classification and the returns on them that are the key consideration for crypto asset accounting purposes.